The annual cost of owning, running, and maintaining an asset over the course of its life is known as the equivalent annual cost, or EAC. EAC is frequently used by businesses to make capital budgeting decisions since it enables them to compare the cost-effectiveness of different assets with different lifespans. EAC can also be used to determine an asset’s best life, whether leasing or buying it is the wiser course of action, the extent to which maintenance expenses will affect an asset, the required cost savings to support buying a new asset, and the cost of maintaining existing equipment.
A discount rate or the cost of capital is taken into account in the EAC computation. The cost of capital is the amount of profit needed to justify a capital budgeting project, such constructing a new factory. Companies utilize the cost of capital, which comprises the cost of debt and the cost of equity, to determine internally if a capital project is worthwhile investing resources in.